Retirement planning: Do you have a financial back-up plan?

Money & Career

Retirement planning: Do you have a financial back-up plan?

A troubling trend in the United States and, to a lesser extent, in Canada these days, largely as a result of the recent economic downturns, is that many retirees are turning to their children for financial assistance, frequently in the form of co-signatures on loans.

Speaking recently to The Financial Post, John Sternal, vice president of marketing and communications at Florida-based leasetrader.com, an online car lease marketplace, noted that a study his firm commissioned found the number of seniors south of the border who asked their children to co-sign a car lease increased 28.9 per cent over the past two years.

Borrowing from the kids The better you plan, the more financial options you have. "Over the last couple of months we really started to see more and more of this activity taking place [in the United States]," Sternal added.

"It's two-fold. It's not just co-signing. The kids, and we are talking people 21 to 28 with established credit, are signing up so their mom and dad can use the car."

Sternal acknowledged that "the numbers are noticeably smaller in Canada due to a better jobs picture and a stronger overall housing market," but he pointed out that the incidence of Canadian children co-signing loans on their parents' behalf was nevertheless up 13.2 per cent during the same two-year time frame.

Nor are these types of arrangements limited to car leases – indebted retirees are asking for their children's help obtaining credit cards, even mortgages. And while it might work well for some families, in other cases the results have been disastrous for the children.

The problem of early retirement With parents unable to repay the loans, some kids are being left on the hook for the debt, and some have had their own credit ratings tarnished in the process. Laurie Campbell, executive director of Credit Canada in Toronto, says it's not altogether surprising to see children coming to the aid of their parents in these troubled times because there's a growing incidence of elderly people in debt.

"Some people are having to retire before they can really afford to because of the economic downturn, and their investments have gone south," she says. "It's a mess for them."

Page 1 of 6 – Have you prepared financially for a comfortable retirement? Find out on page 2.Planning for the worst The best way to avoid getting into financial difficulties in retirement is to plan ahead, taking a cold, hard look at your total retirement finances, your needs, and what might go wrong.

The goal is to have alternatives so you won't have to jeopardize other family members' security. In other words, prepare for the worst and always try to have a Plan B.

"Even before you retire, you should spend some time with your financial adviser, accountant, or family members, and go through all the pieces in your financial portfolio," says Norman Raschkowan, chief investment officer for Mackenzie Financial Corp. "This gives you a framework for arranging your finances, and it can also provide a bit of assurance because most people have more retirement assets available than they think. For example, they tend to forget about things like Canada Pension Plan (CPP) and Old Age Security (OAS) in their retirement planning, or the value of their home."

The importance of a long-term retirement plan Raschkowan adds that you need to think long term in your planning. "When people plan ahead, they often focus on the time they have until retirement, but they tend not to focus on the period after retirement. If they're retiring in 2020, for example, they think about how to structure their finances to get them there, but also must consider that their assets must last for the rest of their lives."

"You need to think about how quickly you want to draw on the capital you've saved," Raschkowan says. "One model I use is that you should take all your financial assets at retirement and plan on withdrawing five per cent a year. That should ensure your capital remains intact, and that way you don't need to worry about short-term fluctuations."

Gaetan Ruest, director of strategic investment planning at Investors Group in Winnipeg, agrees that advance planning is critical to retirement security, and professional advice can make the process much easier.

"You have to start early to save for retirement, and you have to save the right amount, not just any amount," he says. "It can be daunting to do this on your own because you need to consider all your sources of income, not just savings but also CPP and OAS."

"You also need to ask what your expenses will be when you retire, as opposed to when you're working," Ruest adds. "For example, your travel and medical expenses may go up, your commuting costs will go down, and so on. Then you have to compare your income and your retirement expenses and ask if there's a gap between the two. Then you have to consider what you can do to close the gap. It can be difficult to grasp on your own, and this is where professionals can be useful – they have all the necessary tools to help you."

Page 2 of 6 – Discover how to build a solid emergency fund on page 3.Have an emergency fund Another key step in proactive planning is to set aside some money for emergencies.

"Absolutely everyone should have an emergency fund," Campbell says. "That's one reason why these people are having to borrow from their kids – they have no back-up for emergencies such as if the car breaks down or unexpected expenses arise."

How much money should you set aside? "It takes some time to build up this fund so you should start early, but the general rule of thumb is that everyone should have three to six months of net monthly income," Campbell suggests.

"This is particularly important for retirees because they're on fixed incomes, so it's very difficult for them to increase their incomes if they need some extra dollars coming in."

It's much easier to set up this fund while you're still working, by simply setting aside a few extra dollars each week in a high-interest or money market account, so the money can be accessed immediately if required.

If you're already retired, you may need to re-allocate some of your other savings into this account. One option worth considering, if you haven't already used it, is to set the fund up inside a Tax-Free Savings Account (TFSA). That way you can get at the money tax-free, anytime you want, and in the meantime the interest can compound tax-free. Don't create problems "One major reason retirees end up having to borrow from their kids is that they give money that they themselves need to their kids," Campbell says.

"It doesn't make sense to give money to one child, only to have to turn around and borrow from another. And there are cases where there is financial abuse by the children – you can't help the kids at the risk of your own well-being."

Another major cause of financial difficulty is that with interest rates currently so low, it's easy to believe you can simply borrow your way out of any financial difficulties. But with interest rates now poised to rise, those loans can grow into millstones that destroy your longer-term plans. And people tend to forget that although interest rates are low for such arrangements as lines of credit and mortgages, most credit card rates remain in the double digits.

"Credit card debt is a growing problem with seniors," Campbell cautions. "It comes back to living within your means. It's very easy to overspend with a credit card."

Similarly, Campbell advises against borrowing in the form of a reverse mortgage because these simply draw from the value of your single biggest asset – your home – and thus reduce your ability to tap into that asset by selling it at a later date.

"You can look at something like a reverse mortgage, but you need to understand that the costs of these plans are fairly high, and they're really a band-aid solution," she says.

Page 3 of 6 – Find great investment advice for retirement on page 4.Choose carefully Recent stock market performance has been another big cause of financial distress for many Canadian retirees, and unfortunately market volatility is inevitable. But you can help protect your savings by building a diversified portfolio of both equities (stocks) and fixed-income (GICs, bonds, etc.) assets, the former for growth potential and inflation protection, the latter for security of income and capital.

The fixed-income proportion should grow as we age, to reduce the effect of market shocks like what happened in late 2008.

Ruest cautions, however, against the temptation to give up on equities just because of such downturns. "Even if you hit a bad patch, the typical downturn lasts no more than five years, so within 10 years you'll enjoy some growth regardless of the down time," he says.

Why your money will keep working – even when you're not "People tend to think that once they're retired they don't have time to make up for any losses, but you do. You're going to be in retirement for 20 or 30 years, and you don't need all your money at once. Your money doesn't stop working just because you do, so don't move into preservation mode too soon.

"It all depends on your tolerance for risk, but as long as you can look forward five years and see where your income is coming from, you should be okay. After all, you still have two or three 10-year periods ahead of you. Then, as you get on, you can reduce the aggressive nature of your portfolio over time."

Raschkowan says, "There's a simple guideline called the Rule of 100 – subtract your age from 100, and the remainder is the percentage of your portfolio that should be invested in stocks. So at age 60 it should be 40 per cent and at age 80, 20 per cent. That way the volatility in your portfolio declines as you get older."

Good investments for retirees What kinds of investments should you buy as a retiree? "The typical conservative investor should have a range of fixed-income investments such as bond funds, but we also recommend 20 to 40 per cent in equities," Ruest says.

"You should look for equity funds that provide broad diversity, such as Canadian equity funds as opposed to narrower specialized funds. We don't generally recommend speculative investments, although if you're a more aggressive investor you can consider them."

"One good general guideline is to look for quality," Raschkowan says. "You don't have the luxury of time to make up what you might lose on a specific investment so, for example, you should consider common shares that have a history of paying dividends reliably."

Page 4 of 6 – Are conservative investments for you? Find out on page 5.Indeed, it's worth noting that Fundata mutual fund performance statistics show that for the 10-year period up to June 2010, dividend funds had among the best returns of all 56 fund categories and among the lowest volatility rankings.

"If you look at the total return [from dividend funds] over the long term, [dividend] distributions make up the bulk of that return."

Conservative investment options for further down the road "Later on, you can consider some more conservative choices," Ruest says. "For example, you can put some of your money into an annuity or a segregated fund with guaranteed minimum benefits. These types of investments are becoming increasingly popular. You can also consider life insurance, but the catch there is that to get the best price you have to buy it early."

Raschkowan also suggests that if you don't know your way around the markets, you should get some professional advice to ensure the investments you buy are suited to your situation. But be careful about selecting your adviser, and avoid anyone who guarantees you a higher return, or has no professional credentials.

"You have to be very careful about bogus advisers who have no real credentials," Campbell cautions. "They always go after seniors because they have the money. They can be very charismatic and have time to spend with seniors. There are also a lot of Internet and telephone scams around, and they can be very costly, so you need to be very careful."

If all else fails… Of course, situations can sometimes arise in which you absolutely must turn to other family members for financial help, regardless of all the safeguards you adopt, although this should be considered only as a last resort and only if the kids have adequate resources so they themselves aren't imperiled.

Page 5 of 6 – Is credit counselling for you? Find out more on page 6.Raschkowan says many people don't realize how valuable an asset their home is. "If you do find you need to sell your home or cottage, and many people do at some point, then you have to prepare psychologically for the change," he adds.

"There's a bit of denial here for many retirees," Campbell says. "Maybe they're in a home that's far too big for them and that they can't really afford, or they have two cars. You need to look at your environment and see if it makes sense to keep that home, or maybe the second car. You need to ask, for example, whether you should consider selling it if it leads you into having to borrow from the kids. Owning a home is a great thing, but you can end up strapped for cash because the costs impede your lifestyle. It's always difficult to accept change, but downsizing can free up a lot of extra cash and make life much more enjoyable."

Is credit counselling a good option for you?Before you get to that point, though, Campbell recommends that you seek some guidance from a not-for-profit credit counselling service such as Credit Canada. "If anybody is in dire financial straits, he or she should get some professional advice, but again, be careful.We suggest a non-profit counselling service. These organizations are not into their own bottom line; their goal is to help people who are experiencing personal financial difficulties through individualized and confidential counselling."

While Credit Canada operates in the Greater Toronto area, it is a member of the national not-for-profit Canadian Association of Credit Counselling Services and has a toll-free number (1-800-267-2272) you can call for the name and contact information of a member near you.